The Policy Institute, based in Helena, Montana, blends authoritative research and hands-on political engagement to create public policy based on economic justice, fair taxation, corporate accountability and environmental responsibility.

Summary Sheet - Oil and Gas Tax Holiday

By Bob Decker

Executive Director, The Policy Institute
February 10, 2009

HISTORY

(oil and gas tax changes over past 20 years; highlights only)

- 1987/HB 776: Legislature exempted oil and gas production for first two years of production, as long as oil price < $25/bbl. Also exempted small-volume stripper oil and gas wells from severance tax and reduced tax on larger-volume stripper wells. Both exemption and reduction in place with oil < $30/bbl.

- 1987/SB 383: 12-month exemption from net proceeds (property) taxes for new production from oil and gas wells.

- 1993/SB 18: Provided for a series of “tax incentives” to spur production from “enhanced” recovery (horizontal drilling, secondary, and tertiary recovery).

- 1995/SB 412: reflected “Project ’95,” consensus process to simplify O&G taxation; combined state and local taxes into consolidated rates and provided allocation formula for distribution of revenue to state and local governments. (Other 1995 bills noted below served to implement SB 412.)

- 1995/HB 90: exempted less than 3bbl/day stripper wells from state (not local) severance tax (when oil <$30/bbl).

- 1995/SB 338: Exempted new wells from state severance tax for first 24 months.

- 1999/HB 658: reduced tax rate on oil stripper wells less than 3bbl/day from 5.8% to 0.8% (when oil price <$30/bbl).

- 1999/HB 661: Increased stripper oil wells from 10 to 15 bbl/day. Also reduced tax rate on 4-15 bbl/day oil stripper wells.

- 1999/SB 530: Reduced tax rates on post-1999 production for most primary and stripper production. (Note: Fiscal note at the time estimated revenue loss at $2 million per year. From 2003-2007, average annual revenue loss was $46 million per year.)

- 2005/HB 535: Reduced tax rate on oil stripper wells less than 3bbl/day from 12% to 6% (when oil price higher than $38/bbl).

NOTE 1: Oil and gas companies also benefitted from reductions in business equipment taxes:

NOTE 2: Over the period, at least one bill increased oil and gas production taxes, e.g., “Seven Percent Solution” in 1992 special session applied 7% surtax on 29 different taxes, including oil and gas severance taxes.

NOTE 3: Early in the subject period (1987-2007), most tax reductions only occurred when the commodity price stayed below a predetermined value (example: severance rate reductions enacted in 1993 on various categories of oil production only applied when the price of West Texas intermediate crude was below $30/bbl). Thus, if there was a large increase in oil or gas prices, the reduced rate would probably not apply. In recent years, however, the tax reductions have not been tied to price thresholds. Thus, the reductions occurred even when, for example, oil was selling for $80, $100, and $120 per barrel.

NOTE 4: Most tax changes and reductions apply only to the “working” interest in production operations. The working interest tax is paid by the owners and operators of the wells. The “non-working” interest means an interest in the well that doesn’t have anything to do with ownership or operation of the well. For the purposes of discussing holiday taxes and production tax rates, the focus is on the working interest.

Source: for most historical information, a Dept. of Rev. publication, “A Brief History of Significant Coal, Oil, and Natural Gas Legislation.”

MONTANA COMPARED TO OTHER STATES

NOTE: This is a complex part of oil and gas taxation issues because the taxing formulas vary by state. Some states, e.g., Montana, identify various production methods (horizontal, secondary, tertiary, etc.) and associated severance rates, while others are simpler. Some states, e.g., Wyoming, have production AND ad valorem, i.e., property, taxes, while Montana does not have ad valorem taxes on oil and gas. Most states have secondary or indirect methods, such as personal or corporate income tax, of gaining revenue from oil and gas production, but Wyoming, for example, does not have income tax. Some states have a general sales tax, but Montana does not.

OBSERVATION: It is not wise to categorically say that one state “has higher (or lower) oil and gas taxes” than another state without comprehensive and current data that addresses all forms of taxation and ultimately compares apples with apples. However, when good data exists, it is useful to refer to effective tax rates between states when making comparisons. Effective tax rate can be defined as direct tax revenue divided by total production value. Direct tax revenue includes severance (production) tax, property tax, and royalties.

from “Energy Revenue in the Intermountain West: State and Local Government Taxes and Royalties from Oil, Natural Gas, and Coal,” by Headwaters Economics, Bozeman, October 2008.

- “The oil, natural gas, and coal industries are guided chiefly by the location of reserves, and are less able to relocate than are industries with mobile capital resources (such as textile mills or auto-makers). Other factors such as price, access to markets (e.g., oil and natural gas pipelines), and technology have more significant effects on industry activities. We also find no evidence to suggest that the dramatically different effective tax rates in the Intermountain West we have led to more or less investment from state to state. Montana reduced its tax rates and extended incentives to the oil and natural gas industries in the late 1990s. At the same time, Wyoming studied the issue, finding that new incentives were unlikely to stimulate new exploration and drilling, and chose not to alter its tax structure. The results of these choices are clear: Wyoming has captured proportionately higher benefits than Montana from the current surge in energy production value, and there is no evidence that Montana’s tax breaks worked—Montana has stimulated less, not more, energy development than Wyoming and left more than half a billion in revenue on the table.”

NOTE: The Headwaters report deals with oil, gas, and COAL, so several of the report’s charts, comparisons, and opinions incorporate data on coal taxation, which makes it inadvisable, with occasional exceptions, as noted, to make direct comparisons between the oil and gas tax levels of the studied states.

NOTE: The Headwaters report addresses the states of MT, WY, CO, UT, and NM. It does not address North Dakota, which is sometimes mentioned in comparative tax discussions because it lowered its severance tax rates to attract development in the Bakken formation.

Effective tax rates (for oil, gas, and coal combined, from the Headwaters analysis)

NOTE: These effective tax rates include coal, so it’s possible that one state has a very high tax on oil and gas, but a low tax on coal, or vice versa. It is appropriate to refer to the study’s findings on effective tax rates, however, because they are related to the central issue in mineral tax policy debate about the effectiveness of using tax rates to incentivize production or enhance economic development (see below).

“There is no evidence to suggest that Wyoming’s higher effective tax rate has hurt the state, or that Montana’s lower rate has drawn investment from other parts of the energy-producing West. The Montana Department of Revenue estimates that the state left half a billion dollars on the table between 2003 and 2007 (the Department estimated the difference between actual tax revenue and what would have been collected if the incentives had not been adopted).”

WYOMING

1) “Two state-commissioned studies concluded that tax incentives would have little effect on exploration and production, but that different tax rates could result in significantly lower or higher revenue to the public.”

2) “The (Wyoming) studies concluded that tax incentives would not stimulate significant new production or economic activity, but would cost the state millions in lost tax revenue. The studies also found the opposite true: that higher tax rates would produce new revenue with little risk of slowing the energy economy. As a result, in 2000 Wyoming eliminated a 2 percent reduction in its severance tax rate granted the previous year.”

3) “But we also urge caution about drawing too many conclusions about industry activities from tax rates alone. A main message of the Wyoming studies is that tax policy is only one of many factors that influence energy exploration and production, and a small one at that.”

“Industry does not appear to be sensitive to large differences in effective tax rates between the five energy-producing states in the Intermountain West.”

SUMMARY FINDING

“The oil, natural gas and coal industries are guided chiefly by the location of reserves, and are less able to relocate than are industries with mobile capital resources (such as textile mills or auto-makers). Other factors such as price, access to markets (e.g., oil and natural gas pipelines), and technology have more significant effects on industry activities. We also find no evidence to suggest that the dramatically different effective tax rates in the Intermountain West we have led to more or less investment from state to state. Montana reduced its tax rates and extended incentives to the oil and natural gas industries in the late 1990s. At the same time, Wyoming studied the issue, finding that new incentives were unlikely to stimulate new exploration and drilling, and chose not to alter its tax structure. The results of these choices are clear: Wyoming has captured proportionately higher benefits than Montana from the current surge in energy production value, and there is no evidence that Montana’s tax breaks worked—Montana has stimulated less, not more, energy development than Wyoming and left more than half a billion in revenue on the table.”

from S. Gerking, et al, “Mineral Tax Incentives, Mineral Production and the Wyoming Economy, 2000,” and M. Kunce, et al,“State Taxation, Exploration, and Production in the U.S. Oil Industry, 2001.”

(In the late 1990s, the Wyoming state legislature commissioned two academic studies to evaluate the likely impact of tax and/or incentive policies on the pace and scale of energy activities. Key findings of the Wyoming research include:)

- Production tax incentives have little effect on where energy companies choose to explore and drill. The oil and natural gas industries are guided chiefly by the location of reserves, and are less able to relocate than are industries with mobile capital resources (such as textile mills or auto-makers).

- Production taxes are deductable from federal income tax liability so industry does not feel the full benefit of tax increases, or pay the full increase in tax hikes. When taxes are raised, revenue is shifted from the federal to the state government, and vice-versa.

- Production taxes are “downstream” taxes, meaning they are levied only on successfully producing wells. As a result, production taxes have little effect on exploration. Tax policy can change the timing of extraction. A tax on reserves in the ground tends to accelerate extraction as energy companies attempt to “mine out from under the tax.” Taxes on production (i.e., severance taxes) slow production as industry may hold reserves and wait for high prices or other market advantages.

- Other factors such as price, access to markets (e.g., oil and natural gas pipelines), technology, and regulations have more significant effects on industry activities. Considering tax policy alone cannot fully explain industry choices and the resulting geography and pace of energy exploration and production in the Intermountain West.

NORTH DAKOTA

- Oil and gas industry boosters in Montana sometimes say that North Dakota’s tax rate reductions in recent years caused drilling rigs to leave Montana and go to North Dakota. To counter that argument, keep these points in mind:

- North Dakota’s oil and tax system is, like Montana’s, complex. Its tax rates vary with production volumes, location of well (e.g., Indian land), geologic formation (e.g., Bakken), type of drilling technology, etc.

- North Dakota decreased its severance tax rate for wells in the Bakken to attract development specifically for that geological formation, but it is important to understand other factors that affect development decisions:

EFFECT OF HOLIDAY ON TAX REVENUE

- source: “Analysis of Oil and Natural Gas Tax Production Incentives for Production in Calendar Years 2003 through 2007,” Montana Dept. of Revenue, Office of Tax Policy and Research, September 2, 2008.

- Holiday tax rate from 2003-2007 decreases state and local revenue by $258 million (oil = $205 million; gas = $53 million)

- The DOR analysis also calculates the lost revenue from the 1999 reduction in the primary production rate. That tax reduction cost the state and local governments $230 million in the 2003-2007 period.

NOTE: The lost revenue from the reduction in primary production tax rate is not directly related to the issue of the tax holiday, but it is a significant part of the mix of tax breaks and package of “incentives” that have been made for oil and gas taxation. Together, the revenue losses from the holiday rate and the primary production rate reduction make up most of the $500 million in lost oil and gas tax revenue from 2003-2007.

NOTE: Recently published production and tax data from the Dept. of Revenue indicate that the oil and gas tax holiday decreased revenue to the state and counties by $95 million in 2008. For oil, the lost revenue was $69 million during a year when the average price was $95/bbl. For natural gas, the lost revenue was $26 million when the average price was $8.03/MCF.

HOW TO MANAGE INCREASED REVENUE FROM REPEALING/REVISING STATUTE ON HOLIDAY TAX

- Because oil and gas prices are highly variable, so is the revenue from severance taxes. In considering where revenue generated from ending the oil and gas tax holiday might go, it is wise to mention the variability factor and to offer these general policy options:

HOW SB 258 (revision of tax holiday) WOULD HAVE APPLIED TO 2003-2007 PERIOD

- Because the suspension of holiday tax rates in SB 258 takes effect at an oil price of $80/bbl, SB 258, SB 258, if already enacted into law, would have had no effect on oil and gas taxation during the period, 2003-2007 (the period when state and local governments lost $500 million in revenue). That’s because the price of oil did not reach $80/bbl as a quarterly average during that period.

- In 2008, when oil averaged $95/bbl, SB 258, if applicable as law, would have increased state and local revenue by $69 million (this presumes that all quarters of the year had average oil prices greater than $80/bbl). For natural gas ($8.03/MCF in 2008), SB 258 would have increased state and local revenue by $26 million.

OBSERVATIONS ON SB 258

- SB 258 recognizes that tax incentives, such as the oil and gas holiday, should balance the interests and benefits of both the taxpaying constituency and the taxing authority. If the state (and local) governments give up revenue to help the oil and gas industry when commodity prices are down, the oil and gas industry should increase its contribution to public programs when commodity prices are up.

- In the first stages of providing the holiday (dating back to the early 1980s), the Montana Legislature limited the use of reduced tax rates to times when commodity prices were low. After a predetermined price ceiling was reached, the previous (higher) tax rate took effect.

- Opposition to ending the holiday will argue that lower tax rates accelerate development, create jobs, and spark economic development. Here are three responses to this argument:

- Is the oil and gas industry on an eternal “holiday” in Montana? With an oil price threshold of a generous $80/bbl, isn’t it reasonable to expect that the industry could pay the primary production rate? Especially after the hundreds of millions in tax breaks in recent years?

- SB 258 will not compensate for the Legislature’s past largesse with the oil and gas industry, nor would it have an immediate effect (see fiscal note). Instead, it prepares Montana to have a fair relationship with the oil and gas industry next time oil or gas prices climb to high levels.